The slow implosion of UBS investment banking is of interest at Dealbreaker not only because of our sympathy for the good men and women who sell "a whole lot of brown-bagged bottles of liquor to UBS employees every evening,” but also because of UBS management's constantly repeated theme that the investment bank is just a helpful service provider for their real business, which in the Swiss tradition consists of managing rich people's tax liabilityprivate wealth.
The question is whether UBS can shrink the investment banking business enough to satisfy investors and Swiss regulators without disrupting its other operations, losing lucrative clients or costing too much. With a smaller investment bank, UBS expects earnings growth to come from attracting high-net-worth clients with services and products created by linking investment banking and wealth management closer together, especially in Asia. For example, UBS would help a family-owned business in Hong Kong sell shares on the stock market and then offer advice on how to manage the proceeds.
"The increasingly close relationship we enjoy with wealth management allows its clients to more actively benefit from the full capabilities the investment bank offers,” Mr. Kengeter said in an interview this month. “In today’s market and regulatory environment, that proposition has never been more compelling."
Now, this is sort of self-serving and ridiculous. If my family owned a Hong Kong IPO-candidate business, I would want the best capital markets bank to take it public, and then I'd want the best private wealth bank to manage my loot. If those two banks were the same, great, but I'm not going to give that IPO business to a bunch of incompetents just because they work for the same legal entity as a guy who's the best in the world at getting Knicks tickets and investing all of my money in phantom swaps with Kweku Adoboli.
Of course there is something to what Kengeter says. It is more expensive and time-consuming to have multiple financial relationships than to have just one, particularly if you're a dodgy Chinese entrepreneur and getting through KYC checks once is hard enough. And maybe there's some reason to believe that the best people in every "finance" field like to cluster together, so that the best investment bankers beget prestige that lures the best wealth managers. This effect is likely small, though, and if it exists it's, how to put this, probably not so much at UBS.
Really this is not about client benefits, it's about UBS benefits. When Kengeter says "allows its clients to more actively benefit from the full capabilities the investment bank offers," he means "allows UBS to benefit by (1) stuffing investment banking deals into its wealth management channels and (2) overcharging wealth management clients for banking services because at least some of them won't want to be bothered with dealing with multiple banks." (The latter form of price discrimination is, of course, BAC's business model.)
That said. It's easy to say "banks have a conflict of interest when they act as a trusted wealth adviser to you while also trading for their own account and underwriting the company whose shares they're selling you." And they do, of course. And that could lead to clients getting screwed. But there are lots of ways to be screwed. You could, for instance, be screwed because the guy managing your portfolio has been fooled about the quality of the assets by the guy selling them.
Conflicts within banks are made worse by the fact that everyone is in theory playing for the home team - each UBS employee should want the long-term profit of UBS, which is sometimes achieved by stuffing retail with shitty IPO shares and sometimes achieved by not doing that. But those conflicts are mitigated by the fact that most bankers actually care about their own business and their own customers and don't want to screw them to help out another division, and by the even more important fact that those bankers can find out if they're screwing their customers and fight back intelligently. A UBS wealth manager can pick up the phone,* call the UBS IPO banker, and say "Jim, really, is this thing dogshit or what?" And he might get a real answer, because he and Jim eat at the same cafeteria together and have some sort of we're-all-on-the-same-team mentality. He can't expect to get a real answer if he calls the Credit Suisse financing banker on a Credit Suisse-led IPO.
On the other hand, the Credit Suisse banker can't call the UBS wealth manager's boss to order him to buy shares for his clients just because the IPO isn't going well. So it's not totally clear what the optimal setup for screwing clients - or, if you prefer, the optimal setup for avoiding client screwing - is: do you want information sharing and conflicting incentives, or limited-information/limited-conflict adversarial trickery?
I don't know the answer. I'm toying with the notion that a useful lens for thinking about this is the work of Ronald Coase, the Nobel Prize winning economist with a Hasslehoff-in-Germany following in law schools. One of his seminal papers is on "the nature of the firm," and starts from the fact that companies aren't all that capitalist:**
[I]n economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism. The price of factor A becomes higher in X than in Y. As a result, A moves from Y to X until the difference between the prices in X and Y, except in so far as it compensates for other differential advantages, disappears. Yet in the real world, we find that there are many areas where this does not apply. If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so.
Coase's work builds up a theory of transaction costs, positing that economic activity is organized into firms when the transaction costs of allocating resources that way are lower than the transaction costs of allocating them by market/price mechanisms. And he, and the literature that followed him, developed some notions about which sorts organizations would minimize which sorts of transaction costs.
As UBS wrestles with which product/advisory/trading functions it wants to keep in-house to serve/profit off of private banking, and which it needs to divest, I wonder whether there could be a similar transaction cost economics of ripping clients' faces off. Perhaps regulators, or whoever is in charge of thinking about how to reduce the likelihood of clients' getting screwed by banks (clients? maybe?), ought to be looking into that.
** Reminder to GS, Citi, etc.: not email.
** Random aside: Occupy Wall Street's intellectual inspiration has made similar arguments: "if somebody working for Exxon says, 'hand me the screwdriver,' the other guy doesn’t say, 'yeah and what do I get for it?'" This is not entirely true at some investment banks!